ETP Econ Lecture Chapter 32

7/24/2019 ETP Econ Lecture Chapter 32

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ETP Economics 102

Jack Wu


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Key MacroeconomicVariablesThe important macroeconomic variables of an

open economy inclue!

net e"portsnet forei#n investment

nominal e"chan#e rates

real e"chan#e rates


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$et %orei#n &nvestment%orei#n investment inclues forei#n irect

investment an forei#n portfolio investment'

(irect investment! physical capital such asfactory) o*ce) an so on'

Portfolio investment! +nancial asset such ascurrency) stock) bon an so on'

$et forei#n investment , outboun forei#ninvestment - inboun forei#n investment

$et forei#n investment , $et capital out.o/


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asic ssumptionsThe moel takes the economys (P as #iven'

The moel takes the economys price level as

#iven'


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Market for 3oanable%unsThe Market for 3oanable %uns

S = I + NCO

t the e4uilibrium interest rate) the amount thatpeople /ant to save e"actly balances the esire4uantities of investment an net capital out.o/s'

The supply of loanable funs comes fromnational savin# 567'

The eman for loanable funs comes fromomestic investment 5I7 an net capitalout.o/s 5NCO7'


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Market for 3oanable%unsThe supply an eman for loanable funs

epen on the real interest rate'

hi#her real interest rate encoura#es peopleto save an raises the 4uantity of loanablefuns supplie'

The interest rate a8usts to brin# the supply

an eman for loanable funs into balance'


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Copyright2003 Southwestern/Thomson Learning

Quantity of

Loanable Funds

eal

!nterestate

Supply of loanable funds

(from national saving)

Demand for loanable

funds (for domesticinvestment and net

capital outflow)

Equilibrium

quantity

Equilibrium

real interest

rate


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E4uilibrium in Market for

3oanable %unst the e4uilibrium interest rate) the amount

that people /ant to save e"actly balances theesire 4uantities of omestic investment annet forei#n investment 5net capital out.o/7'


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%orei#n9:urrency E"chan#e

MarketThe t/o sies of the forei#n9currency

e"chan#e market are represente by NCOanNX'

NCOrepresents the imbalance bet/een thepurchases an sales of capital assets'

NXrepresents the imbalance bet/een e"portsan imports of #oos an services


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Market&n the market for forei#n9currency e"chan#e)

;'6' ollars are trae for forei#n currencies'

%or an economy as a /hole) NCOan NXmustbalance each other out) or!

NCO = NX

The price that balances the supply aneman for forei#n9currency is the reale"chan#e rate'


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MarketThe eman curve for forei#n currency is

o/n/ar slopin# because a hi#her e"chan#erate makes omestic #oos more e"pensive'

The supply curve is vertical because the4uantity of ollars supplie for net capitalout.o/ is unrelate to the real e"chan#e rate'


12/38Copyright2003 Southwestern/Thomson Learning

Quantity of "ollars #$%hanged

into Foreign Curren%y

eal

#$%hangeate

Supply of dollars

(from net capital outflow)

Demand for dollars

(for net exports)

Equilibrium

quantity

Equilibrium

real exchange

rate


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E4uilibrium in %orei#n9:urrency E"chan#eMarketThe real e"chan#e rate a8usts to balance the

supply an eman for ollars'

t the e4uilibrium real e"chan#e rate) theeman for ollars to buy net e"ports e"actlybalances the supply of ollars to bee"chan#e into forei#n currency to buy assets

abroa'


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E4uilibrium in


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E4uilibrium in



0 &et Capital

'utflow

Net capital outflow

is negative

Net capital outflow

is positive

eal

!nterestate


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E4uilibrium in



(a) The *ar+et for Loanable Funds (b) &et Capital 'utflow

Net capital

outflow! NCO

eal

!nterest

ate

eal

!nterest

ate

(%) The *ar+et for Foreign,Curren%y #$%hange

Quantity of

"ollars

Quantity of

Loanable Funds

&et Capital

'utflow

eal

#$%hange

ate

Supply

Supply

Demand

Demand

r r

E


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PoliciesThe ma#nitue an variation in important

macroeconomic variables epen on thefollo/in#!

overnment bu#et e+cits

Trae policies

Political an economic stability


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overnment u#et(e+cits&n an open economy) #overnment bu#et

e+cits ' ' '

reuce the supply of loanable funs)

rive up the interest rate)

cro/ out omestic investment)

cause net forei#n investment to fall'




eal

!nterest

ate

eal

!nterest

ate


Quantity of

"ollars

Quantity of

Loanable Funds

&et Capital

'utflow

eal

#$%hange

ate

Demand

Demand

r"

NCO

SS

S S

r"

#

E$

r r

%

$ % budget deficit reduces

the supply of loanable funds

" which

increases

the real

interestrate

& 'he decrease

in net capital

outflow reduces

the supply of dollarsto be exchanged

into foreign

currency which

causes the

real exchange

rate to

appreciate

which in

turn reduces

net capital

outflow

E"


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E=ectsE=ect of u#et (e+cits on the 3oanable %uns Market

#overnment bu#et e+cit reuces nationalsavin#) /hich ' ' '

shifts the supply curve for loanable funs to the left)/hich ' ' '

raises interest rates'


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E=ectsE=ect of u#et (e+cits on $et %orei#n

&nvestment>i#her interest rates reuce net forei#n

investment'E=ect on the %orei#n9:urrency E"chan#e

Market ecrease in net forei#n investment reuces

the supply of ollars to be e"chan#e into

forei#n currency'This causes the real e"chan#e rate to

appreciate.


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Trae Policy trade policy is a #overnment policy that

irectly in.uences the 4uantity of #oos anservices that a country imports or e"ports'

Tari=! ta" on an importe #oo'

&mport 4uota! limit on the 4uantity of a #ooprouce abroa an sol omestically'


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Trae Policyecause they o not chan#e national savin#

or omestic investment) trae policies o nota=ect the trae balance'

%or a #iven level of national savin# anomestic investment) the real e"chan#e ratea8usts to keep the trae balance the same'

Trae policies have a #reater e=ect onmicroeconomic than on macroeconomicmarkets'




eal

!nterest

ate

eal

!nterest

ate


Quantity of

"ollars

Quantity of

Loanable Funds

&et Capital

'utflow

eal

#$%hange

ate

r r

Supply

Supply

Demand

NCO

D

D

Net exports!

however! remain

the same

" and

causes the

real exchange

rate to

appreciate

E

E"

$ %n import

quota increases

the demand fordollars


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E=ectsE=ect of an &mport ?uota

ecause forei#ners nee ollars to buy ;'6' nete"ports) there is an increase eman forollars in the market for forei#n9currency'This leas to an appreciation of the real e"chan#e

rate'


28/38


There is no chan#e in the interest rate becausenothin# happens in the loanable funs market'

There /ill be no chan#e in net e"ports'

There is no chan#e in net forei#n investmenteven thou#h an import 4uota reuces imports'


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n appreciation of the ollar in the forei#ne"chan#e market encoura#es imports aniscoura#es e"ports'

This o=sets the initial increase in net e"portsue to import 4uota'

Trae policies o not a=ect the trae balance'


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:apital %li#htCapital fight is a lar#e an suen reuction

in the eman for assets locate in a country':apital .i#ht has its lar#est impact on the

country from /hich the capital is .eein#) but italso a=ects other countries'&f investors become concerne about the

safety of their investments) capital can 4uicklyleave an economy'&nterest rates increase an the omestic

currency epreciates'


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Copyright2003 Southwestern/Thomson Learning

(a) The *ar+et for Loanable Funds in *e$i%o (b) *e$i%an &et Capital 'utflow

eal

!nterest

ate

eal

!nterest

ate


Quantity of

-esos

Quantity of

Loanable Funds

&et Capital

'utflow

eal

#$%hange

ate

r$ r$

D$

D"

E

Demand

S S"

Supply

NCO"NCO$

$ %n increase

in net capital

outflow

which

increases

the interest

rate

" increases the demand

for loanable funds

& %t the same

time! the increase

in net capital

outflow

increases the

supply of pesos which

causes the

peso to

depreciate

r" r"

E


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(iscussionWhich of the follo/in# coul be a conse4uence of

an appreciation of the ;'6' real e"chan#e rate@

a' John) a %rench citiAen) ecies that &o/a

pork has become too e"pensive an cancels hisorer'

b' $ick) a ;'6' citiAen) ecies that his tripto $epal /oul be too costly an cancels his trip'

c' Boberta) a ;'6' citiAen) ecies toimport fe/er /inshiel /ipers for her auto partscompany'

' ll of the above are correct'


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(iscussionWhich of the follo/in# is inclue in the

supply of ollars in the market for forei#n9currency e"chan#e in the open9economy

macroeconomic moel@ a' retail outlet in f#hanistan /ants

to buy /atches from a ;'6' manufacturer' b' ;'6' bank loans ollars to lair) a

;'6' resient) /ho /ants to purchase a ne/

car mae in the ;nite 6tates' c' ;'6' base mutual fun /ants to

purchase stocks issue by a Polish company' ' ll of the above are correct'


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(iscussion&n the open9economy macroeconomic moel) the 4uantity ofollars emane in the forei#n9currency e"chan#e market

a' epens on the real e"chan#e rate' The 4uantityof ollars supplie in the forei#n9e"chan#e market epens

on the real interest rate' b' epens on the real interest rate' The 4uantity of

ollars supplie in the forei#n9e"chan#e market epens onthe real e"chan#e rate'

c' an the 4uantity of ollars supplie in the

forei#n9currency e"chan#e market epen on the reale"chan#e rate' ' an the 4uantity of ollars supplie in the

forei#n9currency e"chan#e market epen on the realinterest rate'


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(iscussionWhich of the follo/in# contains a list only of

thin#s that increase /hen the bu#et e+citof the ;'6' increases@

a' ;'6' supply of loanable funs) ;'6'interest rates) ;'6' omestic investment b' ;'6' imports) ;'6' interest rates) the

real e"chan#e rate of the ollar c' ;'6' interest rates) the real e"chan#e

rate of the ollar) ;'6' omestic investment ' the real e"chan#e rate of the ollar)

;'6' net capital out.o/) ;'6' net e"ports


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(iscussionWhich of the follo/in# is inclue in the

eman for ollars in the market for forei#n9currency e"chan#e in the open9market

macroeconomic moel@ a' +rm in Kenya /ants to buy /heat

from a ;'6' +rm'

b' Japanese bank esires to purchase

;'6' Treasury securities' c' n ;'6' citiAen /ants to buy a bon

issue by a Me"ican corporation'

' ll of the above are correct'


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(iscussionn increase in the ;'6' real interest rate inuces a' mericans to buy more forei#n assets)

/hich increases ;'6' net capital out.o/'

b' mericans to buy more forei#n assets)/hich reuces ;'6' net capital out.o/

c' forei#ners to buy more ;'6' assets)/hich reuces ;'6' net capital out.o/'

' forei#ners to buy more ;'6' assets)/hich increases ;'6' net capital out.o/'


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(iscussionn increase in the interest rate causes

investment to

a' rise an the e"chan#e rate toappreciate'

b' fall an the e"chan#e rate toepreciate'

c' rise an the e"chan#e rate toepreciate'

' fall an the e"chan#e rate toappreciate'

ETP Econ Lecture Chapter 32

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